Quick Summary: The changes proposed by the CSRC to the Qualified Foreign Institutional Investors (QFII) and RMB Qualified Foreign Institutional Investors (RQFII) programmes, if fully implemented, will allow qualified offshore investors to invest in PRC commodity futures, in addition to PRC securities and bonds, for the first time. This will give customers of qualified investors access to a new asset class (commodity futures) and will give commodity market participants the ability to access PRC commodity futures markets without the need to establish a local PRC entity. Whether this route gives access to all PRC commodity futures or just those that are already accessible from offshore (i.e., iron ore, crude oil and purified terephthalic acid futures) will depend on the decisions of the respective PRC commodity futures exchanges and the consent of the CSRC.
The China Securities and Regulatory Commission (CSRC) has published consultation drafts on proposed changes to the Qualified Foreign Institutional Investors (QFII) and RMB Qualified Foreign Institutional Investors (RQFII) programmes. Of note is the expansion in investment scope for QFII and RQFII, which extends the products covered to include RMB commodity futures that are listed and traded on PRC commodity futures exchanges approved by the CSRC.
The commodity futures exchanges will propose eligible contracts for the CSRC’s approval. Although specific details have not yet been provided by the CSRC or commodity futures exchanges, it is widely expected that such eligible contracts could go beyond those already available to international investors (e.g., crude oil futures, iron ore futures and purified terephthalic acid (PTA) futures). With each of these exchanges already considering the launch of new futures products that will be accessible to offshore investors (e.g., technically specified rubber (TSR) futures to be launched by the Shanghai International Energy Exchange), the number of commodity futures is very likely to increase.
Other proposed reforms to the QFII and RQFII programmes include consolidating the regulations into a single ‘qualified investor’ (Qualified Investor) programme, removing the quantitative assets-under-management (AUM) requirements that must presently be met to qualify under the QFII programme, and reducing application processing time. A Qualified Investor will also be able to appoint its affiliated domestic private equity investment fund manager for investment advisory services.
With these proposed amendments, the Qualified Investor programme revives its ‘pilot testing’ status, allowing the CSRC, the State Administration of Foreign Exchange (SAFE), and the People’s Bank of China (PBOC) to monitor and manage foreign investment into domestic PRC markets in a controlled manner. With the expanded scope of eligible investments, the Qualified Investor programme is also likely to attract interest not only from participants in the capital markets space, but also those in the commodities sector.
The latest revisions to the QFII and RQFII programmes represent China’s continued push towards internationalising the RMB, and promoting inbound investments. Based on the timelines from previous consultations by the CSRC, we expect that the new provisions could come into force as early as the last quarter of 2019, with the approved commodity futures contracts announced in early 2020.
Considerations for market participants
The QFII and RQFII programmes are open to investors from many jurisdictions, including those from Singapore and the UK. The total available quota for the QFII programme was recently doubled to US$300 billion, with the approval of the State Council, up from the previous US$150 billion. As of 27 March 2019, only about US$101.4 billion of the QFII quota had been allocated. Approved QFII investors based in Singapore and London were allocated a quota exceeding US$14.2 billion, in roughly equal proportions.
Conversely, under the RQFII programme, RMB 1.94 trillion of the total quota is available, with approximately RMB 661 billion allocated in total. Approved Singapore and London-based RQFII investors were allocated RMB 74.7 billion and RMB 48.5 billion, respectively.
Institutional investors already qualified under the QFII and RQFII programmes with applicable quotas would be able to invest beyond equities and bonds, into commodity futures. Such investors should be aware of the differences when dealing in notionally physically-delivered commodity futures contracts, compared to dealing in fungible dematerialised products such as bonds and securities.
Such expansion of investment scope further opens up possibilities for commercial banks and financial institutions to offer new products and services, especially to customers in the commodities sector.
Commodity firms that happen to have a dedicated fund management company may now wish to consider applying through such affiliated fund managers for a licence and quota under the Qualified Investor scheme. This could potentially provide them with another avenue for offshore access to the PRC commodity futures markets. However, such firms should be mindful of potential issues that may arise, such as from the interaction between their allocated investment quota and meeting the margin requirements for their positions.
Qualification requirements
Eligible foreign institutional investors include fund management companies, commercial banks, insurance companies, securities companies, futures companies, trust companies, government investment management companies and other asset management institutions. Other types of institutional investors recognised by the CSRC include pension funds, charity funds and endowment funds.
A Qualified Investor will have to appoint an eligible domestic commercial bank to act as a custodian for its assets, as well as a domestic securities or futures company (per applicable laws) to execute its investments in the markets. All applications to the CSRC and the SAFE must be submitted through the custodian bank.
The proposed criteria to apply as a Qualified Investor are that:
- the applicant is in sound financial condition and has a good credit standing, with proven experience in securities and futures investment;
- the applicant’s investment managers possess the relevant professional qualifications in its country of domicile (where applicable);
- the applicant has a sound and effective governance structure, internal control system and compliance management regime, and, in accordance with regulations, appoints a supervisor to oversee the legal and compliance requirements of its investments; and
- the applicant’s operations are well-managed, and the applicant has not been subject to major regulatory actions from regulatory authorities in the last three years, or since establishment, as well as any other requirements prescribed by the CSRC in accordance with its prudential regulations.
The processing time for applications to the CSRC and SAFE has been reduced to approximately four weeks, in line with the QFII timelines, as compared to the 16 to 20-week timeline under the RQFII. Viewed alongside the proposed amendments to the monitoring and supervision framework, greater reliance is likely to be placed on domestic commercial banks to conduct the necessary due diligence prior to the submission of applications. Indeed the CSRC, the SAFE or the PBOC would not only be able to take regulatory action against Qualified Investors, but also the custodians, should regulatory breaches occur. It is thus important for Qualified Investors to review and clearly document their relationship with such domestic intermediaries, to reduce the likelihood of future disputes.
Background to the QFII and RQFII programmes
The QFII initiative was established back in 2002, allowing global institutional investors an avenue to invest in the Chinese equities and bonds markets within an approved quota. This was followed by the RQFII programme in 2011, as an expansion to the QFII programme, allowing RQFII quota-holders (initially Hong Kong subsidiaries of Chinese financial institutions only) to invest directly into domestic PRC capital markets with offshore RMB. The key difference between the two is that QFIIs remit foreign currency, which is then converted into RMB, whereas RQFIIs use offshore RMB.
Both programmes have been continuously revised over the years, with progressive relaxation of the restrictions on eligibility, quotas, investment options and the remittance of funds. The RQFII scheme now extends beyond Hong Kong to include, among others, Singapore, Korea and the UK as eligible jurisdictions. More recently, QFII and RQFII investors have been permitted to place foreign exchange hedges on their domestic PRC investments.
In recent years, interest in the QFII and RQFII programmes has waned due to the launch of other access channels, such as the Stock Connect and Bond Connect. The relatively tedious application and onerous compliance requirements, compared to these other channels, have further hampered their attractiveness. Should the proposed amendments come into force, the Qualified Investor programme could see a resurgence in interest.
Reproduced with permission from Reed Smith who retain full copyright to the article. This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.
Peter Zaman has 20 years of practicing as a transactional lawyer in the UK, EU and, most recently, in Asia leaving him with a broad base of experience which allows his practice to be multi-faceted. He has practiced as a partner for 10 years and regularly draws on his experience to help guide, support and collaborate with his clients to enable them achieve their commercial objectives.
Katherine Yang has fifteen years’ experience practicing at leading international law firms. Katherine assists multinational clients from a wide range of sectors, including large energy groups, mining groups, commodities trading companies, machinery manufacturers, pharma and medical device, foodstuff companies as well as media and entertainment groups. Her advice has been praised by clients as “extremely helpful”, “quick, knowledgeable and commercial advice”, “clear and comprehensive”.
Jeffrey Yang is a senior associate in Reed Smith’s Shanghai office. He has over ten years of experience working at major international law firms, including eight years with Freshfields Bruckhaus Deringer. He is trained with Freshfields London office and has practiced with Freshfields in both London and Shanghai.
Matthew Yeo is an associate in the Energy & Natural Resources Group. He enjoys structuring legal solutions to satisfy the commercial and regulatory needs of clients. His background in finance provides him a keen insight into the business challenges that his clients face.
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